Andrew Bell

Anchor, Reporter

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In the eternal stock market struggle between fear and greed, investors in Teck Resources (TECKb.TO) have been showing signs of jitters.

As of late December, the Toronto-based miner’s shares were up more than five-fold so far this year, vaulting above $27 from just $5.34 at the start of 2016 amid a price boom for its three top products: Steel-making coal, zinc and copper. That made it the best performer in the Toronto Stock Exchange’s benchmark index.

But the stock is down from a high of almost $36 a share in late November - and as 2016 came to a close, many investors and analysts were wondering, does Teck still have room to run?

GET MET (COAL), IT PAYS

Teck’s stock has been under pressure in recent weeks amid signs that a manic investor rush into metallurgical coal in China is finally running out of gas.

The rise in the steel-making material has been spectacular. It jumped from US$78 per tonne at the start of the year to more than $300 by Nov. 11 as China cut production at inefficient mines.  But the price has sagged since then.

“Met coal has rolled over and we expect ongoing coal price softness,” Macquarie analyst Matt Murphy said Dec. 19, noting that metallurgical coal was down almost 20 per cent since November. But he upgraded Teck to “outperform” from “neutral”, forecasting C$7.7 billion or $13 a share in free cash flow over the next two years.  

Other analysts who have been upgrading Teck’s shares (belatedly) also warn that the boom in coal is unlikely to last.

“We acknowledge that falling met coal prices will be a headwind, but the exceptional free cash flow is enough to offset this,” Citi analyst Alexander Hacking said in a Dec. 5 note, moving Teck’s stock up to a buy rating from neutral, and hiking his target price to $40 a share from $30.

Goldman Sachs - which lifted Teck to a “buy” rating in mid-November and raised its six-month target price to $41 from $27 a share - also warns that coking coal is set to tumble next year.

Still, Goldman analyst Andrew Quail and his team says the boom in steel-making coal will be enough for Teck to chainsaw its debt load for “a significant deleveraging” of the company’s balance sheet.

ZINC OVERDOSE

Meanwhile, investors who have been grabbing Teck shares for its exposure to soaring zinc prices might want to consider the risks of overdosing on the nutrient. (They include fever and stomach pain - and a greater danger of prostate cancer). 

Zinc has been this year’s star metal, soaring more than 70 per cent in 2016, as investors wager that  shutdowns of aging mines will tighten supplies of the rust-proofing material. About one million tonnes of zinc concentrate has been taken out the market this year, a sizeable chunk of the total supply of 13.2 million tonnes in 2015.

It’s great news for Teck. Goldman estimated the company will receive 24 per cent of its profits next year from zinc, while coal is still the source of 72 per cent of Teck’s earnings. In other words, even though Teck will churn out more than 300,000 tonnes of copper next year, it may be good for less than 4 per cent of total profit.

For Goldman, Teck rates as a “unique coking coal and zinc focused free cash flow machine.”

But high prices for any commodity bring on fresh supply. 

“The rally in [zinc] prices will start to fizzle out in the second half of next year,”  Capital Economics’ commodity watcher Simona Gambarini warned in a Nov 30 report.  She adds that for zinc too, “speculative activity played an important role in the most recent price moves.”

China is determined to become a commodity trading hub and Beijing is anxious to dispel impressions that its markets are simply casinos. At least some of the run-up in coking coal and iron ore this year has been the result of speculation.

The “authorities are continuing to ramp up their campaign against the so-called hot money pumping up commodity prices, with new measures designed to cool price action in iron ore, steel and coal among others,” Reuters’ Clyde Russell cautions.

“The problem is that every time the authorities change the rules in order to force a change in prices, they surrender some of their credibility as a safe, reliable destination for investors.”

Capital Economics predicts that production of zinc will “rebound in 2017 on a combination of growing output and production restarts in China, India, Peru and Australia. Indeed, a few mining firms have already announced that they intend to increase output next year to take advantage of substantially higher prices.”

And any rout could turn ugly.

“Normally when everybody is bullish … the exit for them gets narrower,” BGC Partners base metals specialist Michael Turek told Barron’s last month.

‘DEBT-FREE’, IN SIX EASY QUARTERS

In the meantime, though, the potential cash-generation for Teck is breathtaking, especially from coal.

“We continue to anticipate the supply side to burst the met coal bubble over the next six to 12 months,” Bank of Nova Scotia analyst Orest Wowkodaw said in a Nov. 23 report, reiterating a sector perform rating. “However, until it does, Teck is positioned to generate windfall free cash flow.”

Goldman’s Quail says the coal business could be set to churn out $5 billion in annualized EBITDA (earnings before interest, tax, depreciation and amortization).  “To put this in perspective, the company’s EV [debt and equity combined] is about $19 billion,” he notes.  

Teck’s net debt load still topped $7 billion as of the third quarter, but that could melt away fast.

“We forecast Teck to exit 2017 with a materially improved net debt balance of $4.8 billion,” Scotia’s Wowkodaw said. “The company should be in position to regain its prized investment grade rating.”

The optimism over Teck’s cash-generating ability can be seen right at the top of the mining company, too. In November, Teck president and chief executive Don Lindsay told BNN that investors may not have seen anything yet.

If current spot prices for coal, copper and zinc continue, Lindsay calculates, Teck could be debt-free in six quarters. 

““That,” he said, “is how big it is.”